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Turning Capital to Wealth: A Ranking of U. S. Utilities

Fortnightly Magazine - December 1999

Power $1.7 B = $7.6 B - $5.8 B

Northeast Utilities $0.0 B = $7.9 B - $7.9 B

Investors at Northeast Utilities are just breaking even. Their wealth remains unchanged. By contrast, the investors in NSP now own a company worth $1.7 billion more than the cash they put in (or left in) the business. As a group they are truly better off. Their additional wealth is measured by MVA.

For perspective, here are the top five and bottom three of 1,000 U.S. firms ranked by MVA at the end of 1998.

Rank Company MVA Capital

($ billion) ($ billion)

1 Microsoft $328.3 $11.0

2 General Electric $285.3 $65.3

3 Intel $166.9 $23.6

4 Wal-Mart $159.4 $36.2

5 Coca-Cola $157.5 $13.3


998 RJR Nabisco ($12.2) $35.0

999 CNA Financial Corp. ($13.0) $20.3

1,000 General Motors ($17.9) $85.2

When a company makes a new investment, the firm's capital base expands by the amount of the investment. The company's total value increases to reflect both the increased investment and the market's estimate of the present value of the project's future cash flows. The net value change, or MVA, expands or contracts to reflect the stock market's favorable or pessimistic assessment of the net present value (NPV) of the project. As the difference between market value and invested capital, MVA simply is the market's estimate of the NPV of all past and planned capital spending projects. Taking on positive NPV projects increases MVA and shareholder wealth.

MVA also provides a clear means for judging the success of acquisitions. Acquisitions increase MVA and shareholder wealth only when the market expects the value of the target in the buyers' hands to exceed the purchase price. Earnings per share dilution doesn't matter at all, nor is EPS accretion a guarantee of success. Acquisitions often are made under the false presumption that the price-to-earnings (P/E) ratio stays constant. In fact the P/E ratio fluctuates constantly, and simply adjusts to reflect the MVA of the deal.

Under MVA thinking, too, there is no difference between the purchase and pooling methods of post-merger accounting. There is no evidence of a penalty for purchase accounting and goodwill amortization if the transaction is economically sound. On the contrary, there is clear evidence that firms overpay to get a pooling transaction (for example, the AT&T acquisition of NCR Corp.). The quality of earnings is what matters, and is reflected in a higher or lower P/E ratio. The market compares value added to value paid, regardless of the accounting treatment.

Choosing and implementing optimal dividend policies and financial strategies also becomes easier when increasing MVA is the paramount corporate goal. The distribution of cash through a dividend, for instance, does not change MVA. The firm's capital decreases as the cash is distributed and subtracted from retained earnings. Total market value falls by a similar amount as the shares go ex-dividend. Simply handing shareholders some of the firm's cash cannot increase their wealth, as they already own the company. Withdraw $5 from your bank account that has $100, and you are more liquid but